Escalation clauses in Hong Kong-seated arbitrations
22 September 2022
22 September 2022
In C v D  HKCA 729 the Hong Kong Court of Appeal confirmed that the issue of whether a party has complied with a contractual escalation clause before commencing arbitration proceedings should generally be resolved by the arbitral tribunal, rather than the courts. The tribunal's decision should be final and binding and cannot be relied on to challenge the final award.
The decision follows recent first instance decisions in which the Hong Kong courts have consistently held that questions of compliance with pre-arbitration conditions are questions of admissibility which ought to be resolved by tribunals rather than courts.
In this update, we review these developments and discuss their implications for commercial contracts with Hong Kong-seated clauses.
Escalation clauses (also known as multi-tiered clauses) provide for disputes between contracting parties to be resolved in stages, with negotiation and/or mediation to take place before the relevant dispute is referred to arbitration/the courts. Such clauses are a common feature of commercial contracts, particularly in the context of infrastructure projects or other long-term contracts, where the resolution of disputes via negotiation or mediation is viewed as being more efficient and less disruptive to the parties' ongoing relationship than arbitration or litigation.
However, when drafted as a pre-condition to arbitration they can have the opposite effect; arguments regarding alleged non-compliance can lead to satellite litigation and delays to the arbitration process. The Court of Appeal's recent decision in C v D follows three first instance decisions over the past year alone in which the Hong Kong courts have had to grapple with such arguments.
Kinli v Geotech concerned an application to stay proceedings commenced in the Hong Kong courts in favour of arbitration. The clause provided that " unless otherwise agreed by both parties, the aforesaid arbitration shall not be conducted before either the completion of the main contract or the determination of the subcontract." One of the issues in dispute was whether the clause meant that arbitration could not be conducted until the main contract had been completed and also terminated or determined.
The Court held that "the question of whether a party has complied with the procedure or conditions as to the exercise of the right to arbitrate, as set out in an arbitration agreement, is a question of admissibility of the claim, and the Court has no role to play in relation to such a question, as it does not go to the question of the jurisdiction of the tribunal. It is for the tribunal to decide on admissibility and such decision of the tribunal is final, and not for review by the Court." Accordingly, the Court granted the stay as it was satisfied that there was a prima facie case of the existence of an arbitration agreement.
In T v B, the clause in question provided for disputes to be referred to arbitration in Hong Kong only after the issuance of a completion certificate. T referred the dispute between the parties to arbitration, but B objected that the reference was premature, as a completion certificate had not been issued. The sole arbitrator agreed with B and ruled that he did not have jurisdiction to hear the substantive dispute.
T applied to set aside the award on the grounds that the arbitrator had exceeded the parties' scope of submission to arbitration by construing the dispute resolution clause as he was only appointed to determine the jurisdictional challenge, not to construe the dispute resolution clause.
The Court held that the question of compliance or non-compliance with pre-arbitration procedures is an admissibility issue — not a true jurisdictional challenge. This meant that the arbitrator's decision was not subject to review. The Court reasoned that adopting such a distinction between admissibility and jurisdiction "makes sense conceptually, respects the parties' autonomy, is in line with the general trend of judicial restraint [in arbitration matters], serves to facilitate the fair and speedy resolution of disputes by arbitration without unnecessary expense, and bring Hong Kong in line with the wider international arbitration communities".
C v D concerned a clause which provided that in the event of a dispute:
"the Parties shall attempt in good faith promptly to resolve such dispute by negotiation. Either Party may, by written notice to the other, have such dispute referred to the Chief Executive Officers of the Parties for resolution…
If any dispute cannot be resolved amicably within sixty (60) business days of the date of the Party's request in writing for such negotiation, or any other time period as may be agreed, then such dispute shall be referred by either Party for settlement exclusively and finally by arbitration in Hong Kong …"
When a dispute subsequently arose, D wrote to C's Board of Directors stating that it was “willing to refer the dispute to the parties’ respective senior management teams” for negotiation. C's lawyers responded requesting that further correspondence be directed either through C's lawyers or its CEO. D did not respond but, after 60 business days had passed since the date of its letter, commenced arbitration against C.
C argued that the tribunal lacked jurisdiction to hear the dispute because D had not complied with the escalation clause. The tribunal held that the provisions of the escalation clause had been complied with, there was no issue as to its jurisdiction to hear the case, and issued an award in D's favour.
C applied to the Hong Kong court to set aside the arbitral award on jurisdictional grounds pursuant to article 34 of the UNCITRAL Model Law (adopted by s.81 of Hong Kong's Arbitration Ordinance). The Court of First Instance dismissed C's application and held that questions of non-compliance with escalation clauses are questions of admissibility and not jurisdiction, such that the award could not be set aside under article 34.
On appeal, the Court of Appeal affirmed the Court of First Instance's decision that questions of non-compliance with escalation clauses are questions of admissibility rather than jurisdiction, noting that "there is a substantial body of judicial and academic jurisprudence which supports … the view that 'non-compliance with procedural pre-arbitration conditions such as a requirement to engage in prior negotiations goes to the admissibility of the claim rather than the tribunal's jurisdiction'". The Court emphasised the fact that C's objection was not that the substantive claim advanced by D could never be referred to arbitration at all, but that the arbitration was premature, in that certain pre-arbitration steps should have first been taken. As C's objection was targeted "at the claim" instead of "at the tribunal", its objection went only to the admissibility of the claim rather than the jurisdiction of the tribunal.
The Court further held that, even if they had disregarded the distinction between admissibility and jurisdiction, they would have reached the conclusion that the award was within the terms of the submission to arbitration and therefore could not be reviewed under article 34(2)(a)(iii); the escalation clause should be construed in accordance with the presumption that the parties are likely to have intended all disputes arising out of their relationship to be decided by the same tribunal, unless the language makes it clear that the question of compliance with the escalation clause was intended to be excluded. Having determined that the parties had intended the question of compliance with the escalation clause be determined by arbitration, the Court held that "it follows that it was not their intention that non-satisfaction of such requirement would bar arbitration altogether". As such, the award could not be reviewed for non-compliance with the agreed arbitral procedure under article 34(2)(a)(iv) either.
These decisions confirm that, under Hong Kong law, whether a party has complied with the provisions of an escalation clause (or pre-arbitration conditions more generally) is a question of admissibility rather than jurisdiction, and a tribunal’s decision on this issue is final and not subject to the court’s review.
These decisions of the Hong Kong courts are consistent with a broader global trend of courts in the UK4, Singapore5 and the US6 characterising compliance with pre-arbitration conditions as questions of admissibility rather than jurisdiction.
The practical effect is that tribunals will have a broad range of powers available to them in determining how to proceed when non-compliance with an escalation clause has been alleged, without the risk of having their decision being used as a basis for setting aside the final award. As breach of such a condition will not affect the jurisdiction of a tribunal, the tribunal does not necessarily need to terminate the arbitration upon a finding of non-compliance, but may decide to instead order a stay or adjournment of the proceedings – or indeed, allow the arbitration proceedings to continue if it considers compliance with the escalation mechanism to be futile.
These cases also illustrate the potential unintended consequences that may arise when including pre-arbitration conditions in contracts. Careful consideration needs to be given to the practicality of compliance and the risks of increased costs and delays to the arbitration process associated with potential allegations of non-compliance, in deciding whether or not such provisions ought to be adopted.
Please see our Quickguide for further information on the drafting arbitration clauses generally. Also, please read our recent article for Corporate Disputes Magazine on potential benefits and downsides of escalation clauses, recent court decisions on non-compliance and more tips for commercial parties.
1.  HKCFI 2503
2.  1 HKLRD 279
3.  HKCFI 1474;  HKCA 729
4. Republic of Sierra Leone v SL Mining  EWHC 286 (Comm); NWA & Anor v NVF & Ors  EWHC 2666 (Comm)
5. BTN v BTP  SGCA 105
6. BG Group plc v Republic of Argentina 134 S Ct 1198 (2014)